Sabka Saath, Sabka Vikas: India and ‘competitive federalism’?
Meghalaya
Jammu & Kashmir
Mizoram
Sikkim
7.23
Tripura
9.29
Andaman & Nicobar Islands
9.73
Chandigarh
10.04
Uttarakhand
Assam
Bihar
Pudacherry
Goa
13.36
14.84
16.41
17.72
21.74
Karela
22.87
Himachal Pradesh
23.95
Punjab
Delhi**
Haryana
Telangag
Tamil Nadu**
West Bengal
Uttar Pradesh
Karnataka**
Maharashtra**
Odisha
Pajasthan
Madhya Pradesh
Chhattisgarh
Jharkhand
Andhra Pradesh**
Gujarat**
36.73
37.35
40.66
42.45
44.58
46.90
47.37
48.50
49.43
52.12
Principal-agent problem
With increased state competition and decentralisation
beginning in 1991, the accountability mechanisms that
ensure that the Indian regional states are responsive
to the nation’s wishes are now fewer and less
powerful. Prime Minister Modi’s “Together
with all, Development for all” is increasingly
challenged by the clash of interest between
the federal government and the individual
states. One example is the World Bank
Group’s Doing Business ‘Ease of Doing
Business’ ranking of Indian states. This
score benchmarks economies with
respect to regulatory best practice,
showing the absolute distance to
the ‘frontier’ of best performance.
A closer look at what ‘regulatory
best practice’ entails reveals
that the methodology falls
straight into the competition
61.04
agenda by assuming that
62.00
minimal regulation and
62.45
taxes for business
63.09
are always best.
70.12
71.14
* Source: Asessment of State Implementation of Business Reforms, September 2015, India Department of Industrial Policy and
Promotion
** These states accounted for more than 70% of FDI equity flows to India in the period Apr. 2000 to June 2012. Source: Reserve
Bank of India. “Regional Inequality in Foreign Direct Investment Flows to India: The Problem and the Prospects”
Bibliography/References:
Anguelov, Nikolay. Dec 2015. Lowering The Marginal Corporate Tax Rate: Why The Debate? http://publicpolicycenter.org/portfolio-item/lowering-the-marginal-corporate-tax-rate-why-the-debate/
Watson, Matthew. Feb 2016. Thorstein Veblen: The Thinker Who Saw Through the Competitiveness Agenda. http://foolsgold.international/thorstein-veblen-the-thinker-who-saw-through-the-competitiveness-agenda/
1
Gujarat government website:http://www.gujaratindia.com/business/special-economic-zones.htm
² Reserve Bank of India. “Regional Inequality in Foreign Direct Investment Flows to India: The Problem and the Prospects”
3
Another example was recently found by the European Competition Commissioner in relation to leaked information concerning special deals between Luxembourg and Starbucks and Fiat.
4 The methodology cites among others: Djankov et al. The Effect of Corporate Taxes on Investment and Entrepreneurship, American Economic Journal: Macroeconomics, July 2010. In the abstract: “[greater] effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity” which this author disputes. And Botero and others, The Regulation of Labor, Quarterly Journal of Economics, June 2004 which finds “The strength of the results varies across specifications, but in general they show no benefits, and some costs, of labor regulation.” p.24
Such is the disparity of investment flows that the blue
bubbles signify where investment has been magnified
by a scale factor of 10. The region of Patna, home to
11% of the Indian population in Bihar and Jharkhand,
received a paltry 0.061% of FDI in the period.
Number of Special Ecomomic Zones (SEZs)
Source: Government of India, List of Operational SEZ in India-Source-SEZ India
Repeated cooperation games
The tendency of state competition to race-to-the-bottom can be demonstrated through repeated games. A state government can choose to cooperate
with other state governments by not engaging in the race or they can choose the route of competition. One state’s choice to compete triggers further
deviation towards competition as the repeated games are influenced by the expected strategy of the other player, hence the strategy choice of the
previous game, resulting in a deterministic strategy.
State competition makes it increasingly difficult for them to cooperate again within the model creating a situation of Pareto-inefficient Nash
equilibrium - an assumption justified by their perceived loss if one cooperates “alone”. From the games we can see the Principal-Agent problem:
the sum of the payoffs, understood as the nation’s overall gains (tax revenues, economic growth, increased living standards), is not necessarily the
prefered strategy for the individual players.
Our game attempts to illustrate India’s development since liberalisation began in 1991: Indian legislation and policies increasingly favoured marketorientated approaches and expanded the role of private and foreign investment. States responded differently to liberalisation; some reducing labour
legislation, cutting corporate tax and others continuing the pre-liberalisation strategy of national ‘cooperation’. Liberalisation was an exogenous
factor in the first game, affecting the “autonomy” factor*. This was a necessary condition for the competition game to take place.
What settled things depended upon the political climate*: different political majorities within the individual states are related to different state
performances during the period, especially Modi’s BJP party; historical differences between regions influencing the prefered strategy of each state;
the extent of lobbying by unions or companies; and other states decisions.
1.
• Autonomy (balance of
competence)
Cooperate
• Political party majorities
• Lobbying (corporate and noncorporate)
• Geohistorical context
• Other states’ decisions
2.
State A
50
50
Compete
20
20
55
k.
State A
Cooperate
55
10
10
50
50
Compete
15
15
45
State A
45
0
0
Cooperate
Cooperate
*Exogenous factors influencing
state’s decisions:
Compete
Nagaland
Putna
State B
Arunchal Pradesh
The bubbles’ diameters are proportional to the
percentage of FDI inflows to India that the regional
offices received. The biggest bubble, representing
the state of Maharashtra, is a depiction of the 35% of
India’s total FDI there alone.
Cooperate
State
During his tenure as Chief Minister of Gujarat, Modi convinced the head of Tata Motors to relocate operations in West
Bengal, in the east of India, to Gujarat, in the west, through a personal message and an ready-to-go factory. This
example reveals the rationale behind the competitiveness agenda which, unless checked, leads to government
subsidy of investment. Tata Motors certainly won out of Modi’s deal, but West Bengalis lost jobs
and Gujaratis bore the cost of the ready-to-go factory. Gujarat was also the first state to pass
1
the
Special
Economic
Zone
(SEZ)
Act
2004.
Direct tax benefits of the zones include:
Business Reform Scores*
exemption from commercial tax, sales tax, value added tax (VAT), entry tax, special
1.23
entry tax, luxury tax, entertainment tax, property tax, purchase tax (industry
3.41
2
dependent).
At the heart of the ‘competitiveness’ agenda is the expectation
4.38
that governments unfairly distort markets in favour of corporate - but not
5.93
necessarily national - interests.³
6.37
Special economic zones (SEZs) are treated as foreign
soil by Indian authorities insofar as they are exempt
from state and federal taxes. SEZs benefit from more
flexible labour laws; especially industrial relations.
Compete
Why state competition and ‘competitive federalism’ are myths
Governments that engage in ‘competition’ against each other to attract investment are playing with fire. To the extent that they cut taxes or
otherwise incentivise companies they engage in a race-to-the-bottom with no foreseeable lower bound. Yet this is not in any sense promoting
economic competition. Far from competing for market share through price or quality of goods and service, companies instead engage in using
their political heft to extract rents from taxpayers who bear the costs of ‘profit maximisation’. As Professor Nikolay Anguelov finds, “tax
competition may attract investment, but may not promote overall economic growth, offering support for value-extraction
theories”.
This shows a strong correlation between the number of
SEZs and proportion of FDI.
State B
India arguably seeks to marketise the `business of government`. A feature of the change into a market based competitive
federal system is the government’s revision of the Gadgil formula from 2000, which takes states` previous usage of allocated
funds into consideration when devolving economic support from federal to state government. Advocates believe this
would increase the efficiency of state governments’ use of resources, while the risk of losing future funding serves as an
incentive for states to implement the necessary reforms in order to maximise funds.
Left: the regional distribution of FDI against the
number of SEZs over the 5 year period 2008-2013
Maharashtra
Cooperate
Modi`s promise: competitive federalism
Conventional wisdom argues that a necessary
condition for economic growth is encouraging
investment. Theory suggests lowering corporate tax rates
or other costs increases Foreign Direct Investment (FDI) and capital formation
which then generates economic growth. By getting states to ‘compete’ against each other, Modi’s
competitive federalist theory suggests that the states will draw investment and lead to raised living standards.
FDI as a percentage of total FDI 2008-2013
Compete
This poster has its
origins in research
undertaken by the
authors for The
Economics Debate
2016 between
UCL, LSE and
the University
of Oxford. It was
in preparation
for the question
“Will India be the
next economic
powerhouse” that
much of the outline
took shape. During
the debate against
Oxford there was
much to and fro
over the concept
of ‘competitive
federalism’
which seemed
a particularly
important theory
with relevance to
Indian and global
economic policy
making.
State B
“Sabka
saath, sabka
vikas” or “together
with all, development for all”
was Prime Minister Narendra
Modi’s election promise to
the people of India in 2014.
No easy challenge: India
will overtake China as the
world’s most populous
economy in the next
10 years yet remains
comparatively
poorer and
underdeveloped.
Modi’s development
strategy must improve
the living standards of over
a billion people and deliver
sustained economic growth.
50
50
Compete
5
5
30
30
-15
-15
kth game of n.
In the first game, based on possibilities post-1991’s liberalisation, the game outcome was the compete-cooperate combination. The second game
sees player A continuing with the compete strategy while player B changes strategy from cooperate to compete, because this is now the best
response to the A’s chosen strategy.
From then on, with each reiteration compete-compete becomes the result.
Modi’s competitive agenda believes state competition will boost investment, economic growth and revenues all at once. Our game suggests this
may be true in the short run. Yet over many repetitions, continued competition has one outcome: diminished returns to states, less ability to provide
public goods and services to the Indian people and increasing social cost.
Conclusion
‘Competitive federalism’ is not doing well by India. We do not suggest India is without need of reform, simply that alternative
development strategies to Modi’s competitive federalism are available; ones which can encourage investment alongside an
agenda of even distribution and growth that benefit the Indian people.
India is not confronting this challenge alone. Freer movement of capital globally has meant that countries have found
themselves engaging in competition races. Policymakers have already begun the path of cooperation in the EU through the
planned Common Consolidated Corporate Tax Base, an example that India could follow.
This framework is designed to work for both governments and investors. While investors have only a single set of rules
to work with and also reap the rewards of better functioning societies, governments would no longer face aggressive tax
planning by companies and also see taxable investment allocated to productive uses.
About the authors:
Amin Oueslati, Leise Sandeman and Elliott
Christensen are first year Philosophy, Politics
and Economics BSc students from Salzburg,
Austria; Copenhagen, Denmark; and London, UK
respectively. Each would like to thank Parama
Chaudhury for her support throughout.